Visibility: A Key For Price Risk Management That Works

Could you imagine spending substantial time and resources on a sales, quality or production program that nobody in the company knows about? Very few managers would answer “yes” yet you would be amazed how often it happens with price risk management programs. All too frequently commodity-based producing and processing companies see the risk desk as a black box, difficult to understand and not to be interfered with. Yet it is this very attitude that undermines risk activity itself, especially as it is so highly dependent on a critical alignment of risk desk activities with operations, commercial, logistics, finance and accounting. Just like health & safety programs, effective price risk management requires visibility to everyone in the system and this needs knowledge, situational awareness and an eye to the future as part of day to day activities.

It’s always best to start at the bottom and a fundamental part of visibility lies with training both commercial and financial people. While training new hires is obvious, with a new program it’s the experienced staff that can have the hardest time, as they often forced to recast context for their roles. Training must highlight the risk impact of the decisions they make and the follow-throughs that are now required. Nobody wants to be the weak and hidden link in a long chain. Even more critically, do not overlook instruction for management and the board. They set the targets and policy so arguably their needs are greatest, and often, as we’ve said in other posts, price risk management concepts are foreign to their technical and financial backgrounds.

No plan works in the field without situational awareness. In business it’s a well-designed suite of reports that makes this happen yet many businesses have big gaps here and most often to their detriment. Reports must promote an understanding of the environment (external reports), the company’s position in it (internal reports) and finally its success in dealing with the situation at hand (control reports). A summary of a typical suite of reports is summarized here:

• Externally oriented reports must capture the impact of precipitous price moves, sudden flips in forward curves and swings in interest rates and new market circumstances; all critical to the development of risk strategy.
• Reports on the internal state include the risk model, the heart of any company’s risk program. This describes drivers of risk, the impact of mitigating actions and uncovered exposures. Other reports in this group generally feed the model and reflect the day to day status of physical and hedge activity.
• And finally for the long run, control reports are the measure of risk management effectiveness and well-being. Included in this group is the income statement that should not be underestimated as a risk tool. Unexplainable P&L results often highlight the need for risk management repairs. Slippage and audit reports will highlight the need for improvement and where in the chain corrective action should be taken.

This is a big shopping list but installing the right system will tie a lot of information together and provide a good many of the reports in the table. The investment made will pay itself back through time saved, improved accuracy and free resources to focus on the real business at hand.

Making people think about actions to counter future price risk is a third and often overlooked element of visibility, as the need for price risk management never ends. The attitude that you “can’t plan for risk, you just react when it happens” is a sure-fire way to hobble or even destroy a perfectly good price risk program. The truth is that it can take months and even years to adjust business practices to correct existing problems at the root of a price risk. And further, especially as businesses never stand still, changes to structure and strategy bring their own complications. Like production, sales and worker safety, the ongoing challenges of managing improvement and adapting to change in price risk management must be part the plan. This is especially relevant for functional units independent of the risk desk who can sometimes own the lion’s share of the work required. Without the inclusion of visible risk targets in their planning, essential changes will be overlooked leaving the risk program at a stand still and/or with new exposures forming.

Investing time and effort to build profile and visibility for your price risk management program through the three key elements above will yield results. If you’re unsure how to do it well talk with an expert. The increased understanding of the business and iterative identification and correction of imbalances, inefficiencies and inconsistencies will bring improved control and a better profit focus throughout operating functions. Businesses that ignore this should remember that big losses because of bad price risk management practices can make big headlines. Paradoxically, it is a high level of internal visibility that makes the best price risk management programs the ones you never hear about.

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